Challenges of pricing luxury in commercial aviation – will first class disappear?

Abstract

Nowadays, in the era of commoditization of commercial aviation, airlines’ efforts to restore profitability seem to translate more than ever with a focus on economy class. Many new aircraft are ordered with high-density configurations, and the existing ones are sometimes reconfigured to offer more economy seats, either by reducing the space occupied by those seats, or by shrinking the capacity of the other cabins. Is there still any first class demand and how does it differ from the business class demand? What is luxury in commercial aviation? In this paper, we address the role of the first class cabin in commercial aviation, the challenges of pricing luxury and whether first class still has a future in the years to come versus private aviation.

Keywords

pricing revenue management first class luxury aviation

Introduction

Airlines often face challenges in identifying which aircraft configuration works best given their geographical position and the markets they serve. As aircraft orders are placed many years in advance, it is often the case that, upon delivery, the original commercial purpose might have changed or not materialized given the economic or re impediments. Furthermore, it is of utmost importance to well define the cabin configuration – how many classes of service and how many seats in each class in order to achieve operational profitability as well as operational robustness. As aircraft is often used on more than just one route, it is usually a trade-off that has to be made regarding the number of premium versus economy seats that the markets being served would require (Oancea, 2016). For this reason, as economy demand is usually much larger in volume, it is risky to overstate the need of premium seats (business/first class) that would unnecessarily occupy the space of 2–5 economy seats to the detriment of allowing to accommodate more economy passengers when required (Doganis, 2002). When high load factors are observed for economy and little demand to come is expected for the other cabins, airlines try to partially correct such constraints by usually overbooking the economy cabin and offering upgrades at check-in. Equally, in markets where there is a significant amount of high-yield demand to be captured, not having the right product will mean turning away profitable opportunities. At a glance, it can be noticed that most long-haul airlines operate business and economy cabins and that some have introduced premium economy as a product in between the two – but first class is not an obvious choice, even for airlines based in major cities and where wealthy businesspersons reside. One reason is that the effort of enhancing the service offering and the marketing effort appear very costly, as well as the threat of being unable to steer customers of private aviation towards an airline with a fixed schedule.

Luxury in today’s world

On one hand, more and more travellers are flying nowadays than ever before in history, and it is also due to the constant decrease in fares and the affluence of capacity and fierce competition in many markets, without seeing the same significant growth in volume for first class services.

On the other hand, looking at other industries, it can be noticed that luxury has become more and more marketed and sought by the general public – jewelry, perfumes, bags, shoes, watches, cars, boats, luxurious properties, refined drinks, spas and many more products and services.

Overall, despite many disparities, in most countries, people now have on average more real disposable income than in the past. Consumers appear to be trading up for products that meet their aspiration needs such as luxury products and services and trading down for products which they perceive as commodities. It is a phenomenon known as the “luxurification” of society. Organizations are getting more skilled at embracing this phenomenon and applying premium pricing more effectively. As Yeoman and McMahon-Beattie (2006) note, Luxury has become luxurification of the commonplace, no longer the preserve of the elite. People are enjoying much more material comfort than previous generations.

It is exactly this feeling of enjoyment and exclusivity that the private aviation and its lower-priced cousin, first class, offer to the wealthy. Having a first class of service is not just for pure profit purposes. It also serves as a great marketing lever. The commoditization of commercial aviation had an impact on first class. Some airlines now call first class the cabins that are just in front of economy cabins. The cabins labeled “first class” for short-haul operations are usually a mere improved version of economy seats, and the product differentials of “first class” between airlines can be quite significant. Even within the same airline, depending on the aircraft type, business class on a certain aircraft type may sometimes appear more attractive than first class on another. However, the common understanding of “first class” is the one of long-haul, premium cabin space and service.

In the effort of creating more inviting premium products, many airlines started offering fully flat beds to business class, and sometimes entirely replaced first class, or kept very few seats in the shape of private suites for more exclusivity and space. However, as luxury becomes more accessible to the masses, it also creates difficulty for luxury products to defend that exclusivity (Yeoman, 2011). First class usually offers chauffeur services, higher-quality on-demand meals, more refined list of beverages, better amenities, larger restrooms and sometimes even showers in comparison to the business-class product. However the way each cabin demand is treated with respect to the other is of a great importance. For instance, recent studies have shown that boarding economy passengers through the first class cabin (when first class passengers are already seated) can create negative emotions and anti-social behaviour among economy passengers and can result in first class passengers feeling that they are deprived of privacy. It is the reason why often the boarding for first class is done through a separate corridor (DeCelles and Norton, 2016).

However, luxury was not always about the space and privacy. The era of the supersonic jet, which will surely come back some day with more fuel-efficient aircraft, was the proof that the feeling of exclusivity and luxury can be achieved also through other means (Liebhardt et al,2011). Concorde was not luxurious, but it had only 4 abreast economy type of seats with little headroom, and yet it was very expensive. The ability of reaching London/Paris to New York in just over 3 h was a premium product on its own. In addition, as speed was the definition of the product, there were often more maintenance issues. Indeed, major airlines using it had one Concorde parked as stand-by just in case the assigned one could not leave on time.

Managing First Class

The retail industry has taught us that sometimes creating luxury brands means breaking the rules of marketing, such as those around price positioning relative to similar products. Some brands succeed even when they do not respond to changes in demand, and even when they actually make it difficult for clients to buy, such as high-end fashion items or perfumes. However, luxury brands do suffer as well, and they do have to sell just like any other. They usually go subtly about it, as the emphasis is always on product over price. There are sales in luxury, as price reductions can create opportunities in certain cases to certain clients, but the way the message is reaching a potential customer is very important. In any situation, luxury endures if it can make its stand by delimiting value (Riad, 2011).

However, the airline industry is subject to more pressure due to low profitability margins. Many airlines choose zero first class seat configurations on many a long-haul aircraft simply to save themselves from the embarrassment of not capturing any premium demand, especially in situations where economy is fully occupied and therefore revenue opportunity of capturing more passengers is lost. Even in markets where the luxury demand is present, the belief is that executive jets will be preferred. Many expect that the future will bring more and more air travel, but that the first class will completely disappear (Nicas, 2012). However, it is pleasing to see that some airlines are not following this approach and are trying hard to compete with private jets in the luxury and quality of service they provide. In addition, they are adopting luxurious innovations from other industries such as five-star hotels, providing chauffeur services, in-flight chefs and butlers, high-quality materials and amenities. Notably, the generous A380 aircraft in the recent years has shown that luxurious and uniquely spacious cabins can be offered without reducing significant space from the other passenger cabins.

In terms of revenue implications, as one first class seat usually occupies the same space as a few economy seats, selling too little first class seats would mean losing significant revenue opportunity. However, the majority of airlines try to maximize revenues, not load factors, and overly discounting a luxurious product can impact negatively the results. Simultaneously, as the economy cabin starts to fill up, the revenue management systems react, and the average ticket value of economy cabin increases when the less capacity is available.

Pricing for first class demand requires a completely different mindset. Although it is a costly product – first class unit cost can sometimes reach over 5 times compared with the economy unit cost – a cost-based pricing would not be the correct pricing approach. First class yield is often 6–7 times the economy yield, while business is around 3–4 times. With some exceptions, studies have shown that given the unit cost, the yield and the usual occupancy, it appears that in many international markets, business class is often the most profitable, economy class is sometimes marginal or even unprofitable, and first class is usually unprofitable. (Doganis, 2002). Usually, airlines use a competitive pricing approach for all cabins, but first class is where competitive pricing is also harder to apply, as it may not necessarily be directly linked to the market share or the offering of other airlines. Product-positioning analysis with regard to both private aviation and regular airlines is sometimes required, and attracting first class customers means knowing and understanding better the existing customers and finding ways to be inviting and addressing the needs of potential new clients. First class pricing is also a brand component, and if prices fluctuate too often, the reference price – the price consumers perceive as being the right price for the product – may diminish and never recover.

Another way of maximizing revenues in the case of low occupancy of first class cabins is to overbook the other cabins and upgrade passengers to the upper cabins if required. It is very rare that airlines would aggressively overbook first class irrespective of the statistics of passengers not showing up, and some airlines even never overbook their most luxurious product, as it is of great importance for the brand, image and the overall marketing effect, not just for its revenues.

‘Premiumness’ takes on many different forms for different people, and companies must ensure that they understand trends in consumer behaviour and lifestyle in order to create offers at price points that would be considered worth paying for. Many of the developed and emerging countries have seen positive changes in the appetite for premium products, possibly also supported by wider price ranges and marketing strategies. Based on a study in the UK, it is hypothesized that more consumers are willing to engage in premium markets for a variety of reasons, one of which would be, at least from time to time, not to feel completely bound by price (Allsopp, 2005). In the United States, studies from the Airlines Reporting Corp. have shown that the price gap between economy and premium airline tickets has dropped since 2012, while the percentage of premium airline tickets bought as a share of total tickets has grown since 2012 from 2.3 % to almost 4 %. (Mccartney, 2015). Across the world, IATA reports have shown that despite a drop in volume, premium airfares have been able to maintain better than economy fares on many of the key premium routes.

Conclusion

In recent years, there have been a suite of unfortunate events, such as air crashes, terrorist attacks, security issues, political unrest, economic downfall, which have all negatively impacted the global passenger demand. However, it was observed that the impact on economy traffic was much more severe than that on premium demand, even in percentage terms. Therefore, the course of the declared slow death of first class may not be as definitive, although some airlines continuously tend to reduce the fares of first class seats to make room for more affordable seats. In fact, the OAG data (air travel intelligence company collating air travel data) show a 34 percent rise in the total number of first class seats on planes departing in 2014 compared with 2009. Filtering out the North American and Chinese domestic flights, where “first class” label could be considered a standard “business”, the increase is 21 percent. IATA studies have also shown that despite the recent trends of high pressure on yields, the higher-yielding premium segment can offer an important buffer for the airline’s financial performance. Intangible benefits are equally important, as premium cabins are proven to be excellent marketing levers. Perhaps the main argument to sustain luxury cabins for the years to come is simply that the human desire for privacy and exclusivity is appreciated across cultures and are considered worth paying for.